Bill Ackman is not only battling Herbalife Ltd. (NYSE:HLF) (or Carl Icahn). He has also has been fighting (or at least been on the receiving end of vicious attacks by DA Davidson & Co analyst Timothy S. Ramey). Ackman responded to some comments by Tim Ramey in a letter to investors last night. As predicted….

 

Tim Ramey was quick to respond back to Ackman and issued a letter ‘about Herbalife’, which can be found below.

 According to the October 2, 2013 Pershing Square Investor Letter, Pershing Square has “in recent weeks” covered “more than 40%” of the estimated 24.5 million share short position – about 10 million shares. Pershing Square is said to have replaced it with OTC put options that are far out of the money. It is not clear that the counterparty to this short-cover trade is not now itself short, but the very heavy volume on a strong tape (Herbalife Ltd. (NYSE:HLF) made a new all-time high of $74.94 yesterday) would lead us to believe that a substantial amount of the 10 million share cover has occurred. As of September 13th there were still $28.6 million shares sold short. The September 30th numbers will be announced on October 9th after the market close.

Herbalife

Pershing Square buys out-of-the-money puts. Pershing likely bought out-of-the-money (e.g., $37.50 strike price, at half Herbalife Ltd. (NYSE:HLF)’s current price) puts covering 10 million shares (100,000 puts if conventional 100 multiplier of listed puts) from a very lucky counterparty. We say lucky because it is highly likely that these puts will expire worthless and Pershing’s counterparty will get to pocket the price of the puts at a time when the implied volatility is at historically unprecedented levels.

Also see: Bill Ackman Attacks Herbalife analyst, Explains J.C. Penney Sale

Let’s use the listed Herbalife Ltd. (NYSE:HLF) 1/17/15 $37.5 puts as a proxy for Pershing’s transactions. The Herbalife 1/17/15 $37.50 puts are offered around $6/put covering liquidity of only 4,200 shares. Pershing Square bought puts covering an estimated 10,000,000 shares. Pershing’s counterparty, realizing the difficult position that Ackman is in, easily could have charged Pershing much more.

This new bearish position seems at odds with Pershing Square’s goals. If it truly still believes the go-to-zero thesis, and Mr. Ackman writes in his letter that he does, then it makes no sense to put a time element into this trade. He now needs to be both right on the go-to-zero thesis and right on the timing. On one thing we do agree – Pershing Square has significantly reduced the risk of unlimited losses, but has increased the certainty of a total loss of the original $1 billion short position as the puts expire worthless. The counterparty to his trades indeed has a winning hand.

It will be interesting to see how the market processes this news. Clearly there is capitulation in these actions and that may well send Herbalife Ltd. (NYSE:HLF) shares much higher – and there is the small matter of the remaining ~ 14.5 million shares that are sold-short by Pershing. We would anticipate that the volume will be huge in the next five trading sessions and the stock may very move much higher. We reiterate our BUY rating and $92 price target.

H/T Sital S. Patel